TMI Blog2020 (5) TMI 440X X X X Extracts X X X X X X X X Extracts X X X X ..... we are not inclined to interfere with the order of deletion of Infosys Ltd. as a comparable. Wipro Technology Services Ltd - main ground for exclusion of this comparable is that its entire revenue is on account of related party transactions and it fails the criteria of RPT filter - whether the pre-arrangement between the Citi group and Wipro Limited would make the subsequent rendition of services by this company to the Citi Group fall within the meaning of deemed international transaction as defined under section 92B(2)? - HELD THAT:- A perusal of the aforenoted provision shows that the transaction between an unrelated party and an enterprise would be deemed to be an international transaction if there was any prior agreement between the parties on the basis of which the transaction is being undertaken. There was indeed a prior agreement between Citi Group and the erstwhile Citi Technology Services for rendition of software services. After acquiring Citi Technology Services (now Wipro Technology Services) by Wipro Ltd, since the comparable company continues to deliver services to Citi Group, this entire transaction would be considered as a related party transaction. The pre- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pplied by the Tribunal is in consonance with the legal position discussed hereinabove. No merit in the contentions urged by the Revenue on this ground. Equally meritless is the contention of the Revenue regarding the bar to challenge the comparables after the acceptance of the filters. The filters are applied to narrow down the search to find the comparables that are closest to the assessee. The use of filters has to be necessarily validated from the annual reports. - Decided against revenue. - ITA 201/2018 - - - Dated:- 18-5-2020 - HON'BLE MR. JUSTICE VIPIN SANGHI HON'BLE MR. JUSTICE SANJEEV NARULA Appellant Through: Ms. Vibhooti Malhotra, Standing Counsel for Department of Income Tax. Respondent Through: Mr. Sachit Jolly, Advocate. J U D G M E N T SANJEEV NARULA, J. 1. By way of the present appeal under Section 260A of the Income Tax Act, 1961 ( the Act ), the Appellant (Revenue) assails the order dated 17.04.2017 ( impugned order ) passed by the Income Tax Appellate Tribunal ( ITAT ) in ITA No. 7078/Del/2014 for the Assessment Year ( AY ) 2010-11. The grievance of the appellant is against the exclusion of four comparables introduced by the Tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O under Section 143 (3) read with Section 144C (1) of the Act and the total assessed income was computed at ₹ 5,76,91,078/-, by making two-fold additions to the assessee s taxable income: (a) Addition on account of transfer pricing adjustment at ₹ 5,49,05,106/- ; (b) Disallowance of excess depreciation at ₹ 27,79,910. 5. Aggrieved by the draft assessment order, assessee filed its objections before the Dispute Resolution Panel ('DRP') with regard to the inclusion of the above-noted four comparables. However, the DRP vide order dated 29.10.2014 partially allowed and affirmed the inclusion of the said comparables. Accordingly, the TPO vide order dated 11.11.2014, complied with the direction of the DRP and revised the ALP adjustment at ₹ 3,59,52,769/- to the income of the respondent. The final assessment was completed vide order dated 25.11.2014, assessing the total income of the respondent at ₹ 3,59,58,831/- after making a transfer price addition of ₹ 3,59,52,769/-. 6. Aggrieved by the final assessment order, the respondent preferred an appeal before the ITAT, inter alia assailing the inclusion of the aforesaid four comparab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessment of the arm s length price for benchmarking the present assesee s international transaction? Submissions on behalf of the Appellant/ Revenue 9. Ms. Vibhooti Malhotra, learned senior standing counsel for the appellant/Revenue has assailed the findings of the ITAT for exclusion of the said comparables, inter alia contending that under the TNM method, greater latitude is allowed in choice of comparables. This implies that a broad similarity in the functions of the tax-payer and the comparable is sufficient for the application of the TNM method. She further argued that high turnover of the comparable companies cannot ipso facto be a criteria for excluding them, unless there is functional dissimilarity. Once a comparable passes the filters applied by the TPO, and the same are accepted by the taxpayer-assessee, no further challenge can be made to allege functional dissimilarity between the tested party (taxpayer) and the comparable. The Tribunal erred in deleting the comparable without considering the specific findings of the TPO and DRP on their comparability. Ms. Malhotra filed a detailed note discussing the concept of TNM method viz impact of turnover, size, bra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e further relied on OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration, 2017, which reads as under: 2.68... One strength of the transactional net margin method is that net profit indicators (e.g. return on assets, operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the CUP method. Net profit indicators also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than gross profit margins. Differences in the functions performed between enterprises are often reflected in variations in operating expenses. Consequently, this may lead to a wide range of gross profit margins but still broadly similar levels of net operating profit indicators. In addition, in some countries the lack of clarity in the public data with respect to the classification of expenses in the gross or operating profits may make it difficult to evaluate the comparability of gross margins, while the use of net profit indicators may avoid the problem. [Emphasis Supplied] 11. Ms. Malhotra also contended that material di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lhotra, further contended that the fourth comparable company, Thirdware Solutions and Sales Ltd., was removed on the ground of diversified operations and absence of any segmental data of revenue. The TPO had included this company after observing its annual report and noting that it is a software service company. Software development, implementation and support services are various sub-segments of software development services. Even other services provided by the comparable, such as implementation and management services of software applications, are in the realm of software services and are performed by software engineers. The sale of license by the comparable constitutes only 2.2% of its total sales and therefore the said comparable ought not to be deleted from the list of comparables. She further argued that ITAT cannot engage in cherry picking of comparable companies and delete the companies which they feel are not suitable for calculation of arm s length price, in the case of the assessee. In support of her submissions, Ms. Malhotra relied upon the judgments of this court in Rampgreen Solutions Pvt. Ltd. v. CIT,[2015] 60 taxmann.com 355 (Delhi) and Chryscapital Investment A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t way. The submission that the two comparables offer an illustration of an identical transaction being conducted in an uncontrolled manner overlooks the effect of the Tata brand on the performance of the impugned comparables. The question was not merely whether the margins earned by the Tata group in providing captive service to the Citi entities were at arm s length. The question was whether they offered a reliable basis to re-calibrate the PLI of the Assessee whose scale of operations was of a much lower order than the two impugned comparables. The mere fact that the transactions were identical was not, in terms of the law explained in the above decisions, either a sole or a reliable yardstick to determine the apposite choice of comparables. 17. Mr. Jolly concurred with the established principle of law that a comparable cannot be deleted on the sole ground of high turnover and supernormal profits, as held in Chryscapital (supra), however, he argued that in assessee s case, the Tribunal deleted the four comparables on multiple grounds. The comparable - Infosys Ltd. was deleted due to the presence of high brand value, size of their operations, difference in the services rend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ysis/Reasoning 20. We have considered the rival submissions of the parties. We have also carefully perused the records and examined the case laws cited by both the parties. The issues raised by the appellant are in fact no longer res integra. This Court has consistently held that only those comparables which are functionally similar to the assessee (tested party) and operate in a similar business environment as that of the assessee should be used for benchmarking to arrive at an accurate calculation of arm s length price. 21. We do not agree with the contention of the appellant that TNMM does not require functional similarity between the tested party and the comparable. Section 92C (1) of the Act contains provisions relating to various methods for calculation of ALP. Rule 10B of the IT Rules provides for calculation/determination of ALP. Rule 10B (2) describes the grounds on which the comparability of an international transaction (or a specified domestic transaction) with an uncontrolled transaction should be based on. This sub-rule reads as follows: Determination of arm s length price under section 92C 10B(2) For the purposes of sub-rule (1), the comparability of an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In other words, given the data available, if the distorting factor can be severed and the other data used, that course has to be necessarily adopted. 40. In the present case, this Court holds that once Brescon, Keynote and Khandwala Securities are held to be functionally similar to the assessee, they would be included as comparables, notwithstanding their high profit margins, provided that the material difference on account of such high profit margins can be eliminated under the Rule 10B(3) analysis. [Emphasis Supplied] 22. In Chryscapital (supra) it has also been held that while adopting TNMM, comparability of a controlled international transaction with the uncontrolled transaction has to be seen in the light of the functions performed, taking into account the assets employed and the risks assumed by the parties, as per Rule 10 B (2). These parameters cannot and should not be relaxed even while employing a method like TNMM, where the compared net margins of profit may be arguably unaffected by the external factors surrounding the companies. The determination of ALP, therefore, has to necessarily confirm to the mandate of Rule 10B. The characteristics of the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us that the comparables selected and the tested party must be functionally similar for ascertaining a reliable ALP by TNMM. Rule 10B(2) of the Income Tax Rules, 1962 also clearly indicates that the comparability of controlled transactions would be judged with reference to the factors as indicated therein. Clause (a) and (b) of Rule 10B(2) expressly indicate that the specific characteristics of the services provided and the functions performed would be factors for considering the comparability of uncontrolled transactions with controlled transactions... XXXX 32. In the present case, the Tribunal noted that Vishal and eClerx were both engaged in rendering ITeS. The Tribunal held that, once a service falls under the category of ITeS, then there is no sub-classification of segment . Thus, according to the Tribunal, no differentiation could be made between the entities rendering ITeS. We find it difficult to accept this view as it is contrary to the fundamental rationale of determining ALP by comparing controlled transactions/entities with similar uncontrolled transactions/entities. ITeS encompasses a wide spectrum of services that use Information Technology based deliver ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bility analysis by TNMM method may be less sensitive to certain dissimilarities between the tested party and the comparables. However, that cannot be the consideration for diluting the standards of selecting comparable transactions/entities. A higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable ALP. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in PLI must trigger further investigations/analysis. 44. Consideration for a transaction would reflect the functions performed, the significant activities undertaken, the assets or resources used/consumed, the risks assumed. Thus, comparison of activities undertaken/functions performed is important for determining the comparability between controlled and uncontrolled transactions/entity. It would not be apposite to ignore functional dissimilarity only for the reason that its impact may be reduced on account of using arithmetical mean of the PLI. The DRP had noted that eClerx was functionally dissimilar, but ignored the same relying on an assumption that the functional dissimilarity would b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee even if the transactions are said to be identical. The relevant portion of the said judgment is extracted herein below: 15. In a large number of decisions this Court has emphasized, that for there to be reliable benchmark studies for determining ALP not only the comparables have to be functionally similar but should have similar business environment and risks as the tested party. A detailed exposition of the legal position with specific reference to Rule 10B(2) of the Income Tax Rules, 1962 is found in this Court's decision in Chryscapital Investment Advisors (India) Pvt. Ltd. v. DCIT 376 ITR 183 (Del) as under: 30. The reasoning adopted in various judgments noticed above, shows that functional analysis seeks to identify and compare the economically significant activities and responsibilities undertaken, assets used and risks assumed by the parties to the transaction. Quantitative and qualitative filters/criteria have been used in different cases to include or exclude comparables. The intuitive logic for excluding big companies from the list of comparables while undertaking the FAR analysis of a smaller company is attractive, given that such big companies prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... compared transactions, or between enterprises entering into such transactions are likely to materially affect the price or cost charged or paid or the profit arising from such transaction in the open market or reasonably accurate adjustment can be made to eliminate the effects of such difference. XXXX 27. There is merit in the contention of the Assessee that the scale of operations of the comparables with the tested entity is a factor that requires to be kept in view. TCS E-Serve has a turnover of ₹ 1359 crores and has no segmental revenue whereas the Assessee's entire segmental revenue is a mere 24 crores. As observed by this Court in its decision in Pr. CIT v. Actis Global Service (P.) Ltd. [IT Appeal No. 417 of 2016, dated 5-8-2016] Size and Scale of TCS's operation makes it an inapposite comparable vis-a- vis the Petitioner. As already pointed out earlier there is a closer comparison of TCS E-Serve Limited with Infosys BPO Limited with each of them employing 13,342 and 17,934 employees respectively and making ₹ 37 crores and ₹ 19 crores as contribution towards brand equity. When Rule 10(B) (2) is applied i.e. the FAR analysis, namely, f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ITAT, we find that none of the comparables have been excluded solely on the ground of high turnover. The primary reason for excluding the four comparables in question is on account of the dissimilarity in the overall profile of the said comparables with the respondent-assessee. 28. Let us briefly evaluate the reasoning of the ITAT for deleting the comparables. As regards the first comparable-Infosys Ltd., it possesses huge tangibles of more than ₹ 1,00,000/- Crores. It is a full-fledged risk bearer with a turnover of more than ₹ 12,000/- Crores. The functions of Infosys Ltd. are highly diversified, and branching out into product conceptualization, core design, research development to marketing and sales of products, etc. No such function is carried out by the assessee. Being a captive service provider, its function is completely confined to software development services for its AE. There are no intangibles owned by the assessee and it incurs no expenditure on research development. We find that these distinguishing factors are highly substantial and cannot be ignored or severed from the comparison. The contractual terms of the transaction will be heavily influenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted provision shows that the transaction between an unrelated party and an enterprise would be deemed to be an international transaction if there was any prior agreement between the parties on the basis of which the transaction is being undertaken. There was indeed a prior agreement between Citi Group and the erstwhile Citi Technology Services for rendition of software services. After acquiring Citi Technology Services (now Wipro Technology Services) by Wipro Ltd, since the comparable company continues to deliver services to Citi Group, this entire transaction would be considered as a related party transaction. The pre-arrangement between Citi group and Wipro Ltd. is a deemed international transaction as per Section 92B (2). Therefore, we are of the considered view that this comparable has been rightly deleted since it is no longer an uncontrolled transaction and cannot serve as a comparable in the benchmarking mechanism for the present assessee, since the RPT filter of this company failed to meet the filter criteria of 25% of RPT, as applied by TPO. The Tribunal in a similarly situated case, deleted Wipro Technology Services Ltd, since it had ceased to be an uncontrolled transacti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... les is as follows: (iii) Persistent Systems Ltd.:- XXXX 9. We have heard the rival submissions, perused relevant findings given in the impugned order as well as the material referred to before us. From a perusal of the annual report of PSL it is seen that this company deals with various products and it has been stated that it has realised more than 3000 products in the last five years and it is leader in the world of outsource software product development. The break-up of income under the head software services and products both exports and domestic, it is seen that there is no segmental information as to how much is the revenue from software services and how much is from the products. This is evident from a detailed report given at page 46 of the paper book. In absence of such segmental information it is very difficult to come to a conclusion as to whether the margin of this company also includes the sale of products. Moreover, as pointed out by ld. Counsel, commission paid to agents on sales is also indicative of the fact that there are sale of products. Thus, we find it very difficult to include such a comparable into the basket of comparables for bench marking ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mmissioner of Income Tax-3 versus Fiserv India Pvt. Limited, ITA N0. 17/2016. The absence segmental data is a factual finding that is not in serious challenge before us. Thus, the Court is not persuaded to find any infirmity in the view taken by ITAT viz the third and fourth comparables. 34. In view of the above, it emerges that none of the comparables have been excluded on the ground of high turnover alone. The test of functional similarity applied by the Tribunal is in consonance with the legal position discussed hereinabove. Therefore, we do not find merit in the contentions urged by the Revenue on this ground. Equally meritless is the contention of the Revenue regarding the bar to challenge the comparables after the acceptance of the filters. The filters are applied to narrow down the search to find the comparables that are closest to the assessee. The use of filters has to be necessarily validated from the annual reports. Since the TPO would have to do this exercise on the basis of the actual data in the report of the comparables, he would surely have the freedom to adopt or reject the comparables. We cannot hold that merely because a comparable clears the filters, its in ..... X X X X Extracts X X X X X X X X Extracts X X X X
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